Split-dollar life insurance is not an insurance product, nor is it a reason to buy life insurance. Rather, it is a strategy for sharing the cost and benefits of a permanent life insurance policy. Any permanent life insurance policy that builds cash value can be used.

What Is Split-Dollar?

Most split-dollar life insurance plans are used in business settings between an employer and employee, or a corporation and shareholder. However, plans can also be established between individuals—sometimes called private split-dollar arrangements—or through an irrevocable life insurance trust (ILIT).

Features

• In a split-dollar plan, an employer and employee sign a written agreement describing how they will share the premium cost, cash value, and death benefit of a permanent life insurance policy.
• The agreement states what the employee must accomplish, how long the plan will remain in effect, and how it will end. It also includes provisions restricting or terminating benefits if the employee leaves the job or fails to meet agreed performance metrics.
• Because split-dollar plans are not subject to the rules of the Employee Retirement Income Security Act (ERISA), there is flexibility in how an agreement can be drafted. They must still meet specific legal and tax requirements. An attorney or tax advisor should be consulted when drafting the documents.
• Employers frequently use these plans to provide supplemental executive benefits and help retain key employees.
• Split-dollar plans also require recordkeeping and annual tax reporting. Generally, with some exceptions, the policyowner is also the owner for tax purposes.
• The usefulness of split-dollar plans is also limited by how the business is structured—for example, as an S corporation or C corporation—and whether plan participants also own the business.

Background

Split-dollar plans have existed for years. In 2003, the IRS published new regulations describing two acceptable split-dollar arrangements: economic benefit and loan (Ref. 2). Although some tax benefits were eliminated that year, split-dollar plans offer advantages such as:

• Term insurance: This is based on the IRS interim table of one-year term premiums per $1,000 of life insurance protection, using Table 2001 rates. The cost may be lower than the actual cost of coverage, particularly if the employee has health problems or receives a rated classification.
• The ability to use corporate dollars to pay for personal life insurance: Plans can amplify the benefit, especially if the corporation is in a lower tax bracket than the employee.
• Low interest rates: These are available if the applicable federal rate (AFR) is below current market interest rates when the plan is implemented. Loan-based plans can retain the interest rate in effect when the plan was adopted, even if rates rise later.
• Options to help minimize gift and estate taxes.

Economic Benefit Arrangement

• Under the economic benefit regime, the employer owns the policy, pays the premium, and endorses or assigns certain rights or benefits to the employee. The employee can name the beneficiaries who would receive a portion of the policy's death benefit. The value of the economic benefit the employee receives is calculated each year.

• Term insurance is valued using the annual renewable term rates in Table 2001, and the policy's cash value benefit is any increase that occurred during the year. The employee must recognize the value of the economic benefit received each year as taxable income. However, if the employee pays a premium equal to the value of the term life insurance or cash value received, no income tax is due.

• A non-equity arrangement is one in which the employee's only benefit is a share of the term life insurance. In an equity split-dollar plan, the employee receives term life insurance coverage and also has an interest in the policy's cash value. Plans may allow the employee to borrow or withdraw part of that cash value.

Loan Arrangement

• Under a loan arrangement, the employee owns the policy and the employer pays the premium (Ref. 3). The employee grants the employer an interest in the policy through a collateral assignment. A collateral assignment places a restriction on the policy, limiting what the employee can do without the employer's consent. A typical assignment allows the employer to recover loans made upon the employee's death or termination of the agreement.

• The employer's premium payments are treated as loans to the employee. Technically, each year's premium payment is treated as a separate loan. Loans can be structured as term or demand loans and must carry an appropriate interest rate based on the AFR.

• The loan's interest rate varies depending on how the agreement is drafted and how long it will remain in effect.

Terminating Split-Dollar Plans

• Split-dollar plans end upon the employee's death or on a future date specified in the agreement, often retirement.
  
• If the employee dies prematurely, the arrangement determines whether the employer recovers the premiums paid, the cash value, or the outstanding loan balance. Once repayment occurs, the employer releases any policy restrictions, and the employee's designated beneficiaries, which may include an ILIT, receive the remainder as a tax-free death benefit.
  
• If the employee fulfills the term and requirements of the agreement, all restrictions under the loan arrangement are released, or ownership of the policy is transferred to the employee under the economic benefit arrangement.
  
• Depending on how the agreement was drafted, the employer may recover all or part of the premiums paid or cash value. The employee now owns the insurance policy. The policy's value is taxed to the employee as compensation and is deductible for the employer.

Who Owns a Split-Dollar Policy?

That depends on the arrangement. Under a “loan” arrangement, the employee owns the policy and the employer pays the premium. Under an “economic benefit” arrangement, the employer owns the policy, pays the premium, and endorses or assigns certain rights or benefits to the employee.

What Benefits Does a Split-Dollar Plan Offer the Employee?

First, the employer pays the premium. Loans and withdrawals can be tax-free, and cash values may grow tax-deferred (Ref. 4).

What Benefits Does It Offer the Employer?

The employer can choose who receives the benefit. There are fewer restrictions than with traditional plans, and plan costs may be lower.4

Like many nonqualified plans, split-dollar arrangements can be a useful tool for employers looking to provide additional benefits to key employees.

References and Notes

1. Cornell Law School. "Taxation of Split-Dollar Life Insurance Arrangements."
2. U.S. Department of the Treasury. "Treasury and IRS Issue Final Regulations on Split-Dollar Life Insurance Arrangements."
3. Nationwide.com. "Split-Dollar Plans."
4. Nationwide.com. "Split-Dollar Plans."

--